Financial Regulatory Forum

Bank of America’s mortgage-fraud deal yields quick impact; message may not be what enforcers wanted

By Guest Contributor
August 26, 2014

By Stuart Gittleman, Compliance Complete

NEW YORK, Aug. 26, 2014 (Thomson Reuters Accelus) - It took just one day for U.S. Attorney General Eric Holder’s announcement Thursday that Bank of America would pay $16.65 billion over charges of fraudulent mortgage origination, securitization and servicing to have an impact.

But the impact was probably one of the last things Holder wanted to see as a result of the deal.

On Friday, a Sacramento federal jury acquitted four defendants on charges of mortgage fraud, after hearing legal expert William K. Black testify that the defendants could not have defrauded their lenders because lenders during the buildup of the credit bubble did not rely on the veracity of loan applications. An attorney for the defendants said their position is supported by statements in the Bank of America settlement.

Sacramento is in the federal court system’s Eastern District of California. The district includes the state’s Central Valley, which has been called “Ground Zero” for fraud during the credit and housing bubble.

Black, a law professor at the University of Missouri-Kansas City, was a federal housing official during the savings-and-loan meltdown in the late 1980s. His referrals for federal fraud prosecution resulted in the conviction of hundreds of bankers, many of whom went to federal prison.

Before, during and since the credit buildup, Black has been warning that control-person accounting fraud lets bankers drain assets for their own benefit before the bank collapses and needs a bail-out, and that the fraud can be forensically detected before it destroys a banking or an operating business.

Federal judge Lawrence K. Karlton let the defense argue, reportedly for the first time in a federal criminal trial, that lenders didn’t care whether a loan application was truthful and that the falsity of an application was not material because the loan would have been approved whether it was true or false.

“Bill Black testified that the two mortgage lenders in our cases … were involved with what he calls ‘control fraud’[and] actively encouraged stated income ‘liar loans’ without caring at all whether the stated income (and other info) was true or false because they knew they were going to package and sell the loans to others,” John Balazs, one of the defense lawyers, told Compliance Complete.

“[A]s a result, any misrepresentation was not ‘material’ to the lender’s decision whether to approve the loan. … [a]nd materiality is a necessary element to convict for mail fraud,” he added.

There were “statements in the BofA and [JPMorgan Chase] settlements to support this, (such as) the Clayton Holdings reports that showed most loans did not even meet the lender/investors own guidelines,” Balazs said. Clayton Holdings LLC provides information about loans to the loan securitization industry.

He also said a study by the Mortgage Asset Research Institute, Inc. estimated that 90 percent of stated income loan applications during this period had overstated incomes by 5 percent or more and that almost 60 percent of such applicants exaggerated their incomes by more than 50 percent.

“As far as I know,” the jury was the first to hear the criminal defense that lenders ignored lies and missing documentation during the lending and securitization stampede, but it should be a precedent, Balazs sadi. ” I’d hope this type of materiality defense would be allowed in future cases,” he said.

Black and the defense attorneys told the Sacramento jury that if Holder and the U.S. Attorneys and state attorneys general who touted the settlement could not find even one banker to charge civilly, not to mention criminally, for Bank of America’s admitted misconduct, it’s wrong, not just unfair, to prosecute borrowers.

Jailing borrowers will not reform an industry if a borrower’s ability to repay is unimportant to lenders because they quickly pass potential problems to other participants in the system, said Black and the defendants’ lawyers.

“The big banks and other lenders made as many loans based on patently false information as they could, packaged them as securities and passed them up the chain to Wall Street’s investment and management bankers, who peddled them to an unsuspecting public,” Tim Pori, another defense lawyer involved in the case, told The Sacramento Bee after the verdict.

“No bank executives have been prosecuted. Sure, there have been multibillion-dollar settlements with some big banks, but none of their officers, the ones who really pulled the strings, will ever see the inside of a cell,” Pori added.

In addition to the materiality defense, Balazs said he hopes “the verdict causes [U.S. Attorney Ben Wagner]to readjust [his] priorities and investigate criminally the true culprits of our country’s financial collapse, the mortgage lenders’ officers who committed the real fraud, not those who allegedly lied on the industry’s ‘liar’s loans’.”

“Criminal trials are inherently uncertain endeavors. [The verdict] not dissuade us from pressing forward in the many other mortgage fraud cases currently pending in this courthouse,” Wagner told The Bee.

Wagner’s office has convicted many mortgage fraudsters at the strip-mall level, but he may also be a less-sung hero behind another large mortgage settlement, the $13 billion one last November with Chase. The bank reportedly settled with Holder, Wagner’s boss, after Wagner threatened to file a highly detailed complaint against the bank unless it accepted Holder’s more innocuous version.

 (This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)

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